Tricks To Manage Your Working Capital Cycle Like A Pro
Working capital cycle is an important financial term that every business person must understand to operate their organisation/firm successfully. This financial concept or term enables businesses to calculate the duration for which their money will be tied up in stocks and inventories.
Here, business persons can rely on cash flow statements along with the working capital cycle to assess the pattern of money flow in and out of business and assure there is enough money to cover day-to-day business operations. Read on to know more about the working capital cycle, effective ways to manage it and other details.
Working Capital Cycle: An Overview
In a business, the working capital cycle refers to the length of time required to convert working capital (the difference between current assets and current liabilities) into cash. Understanding this allows businesspersons to manage their company’s cash flow efficiently and assess how fast they will get money to operate business activity or ensure business growth. The working capital cycle is expressed in days, and the shorter the days, the better a business at managing its finances. Here, the discussion must move to the working cycle formula to help businesses understand the days mentioned earlier.
Formula To Calculate Working Capital Cycle
The working capital cycle formula is as follows,
Working capital cycle= Inventory days + receivable days – payable days
An example will help business persons to better understand the above-mentioned formula,
Inventory days = 95
Receivable days = 20
Payable days = 90
Working Capital Cycle = 95 + 20 – 90 = 25
Therefore, according to this formula/calculations, the organisation will be out of cash for 25 days before full payment.
The working capital formula helps businesses measure how quickly they can turn their current assets into cash. This cycle gives business persons a glimpse into the future of their organisation/firms.
When individuals get to know about the working capital cycle, they can learn the time needed to receive full payment as well as the duration they will have less money.
Importance of Working Capital Cycle
Businesses primarily depend on free cash flow, meaning they need enough cash to cover operational costs, such as purchasing raw materials and paying salaries to employees. If they can predict how fast they will receive money in their business, they can plan and prepare to budge accordingly. This prediction or calculation comes through a working capital cycle.
Now that the concept of a working capital cycle is clear to business persons, we can focus on effective ways to manage it; read on.
Ways To Manage Working Capital Cycle
Here is a list of ways to manage the working capital cycle in an effective manner,
- Selling Inventory Quickly
Businesses can increase sales by adopting different market strategies, such as giving discounts, loyalty cards, reward points etc. These strategies will attract more customers and help you clear inventories at the earliest. Businesses can plan out several advertisement techniques here, especially for items long stocked in the list. Marketing these products may boost sales and clear the inventories quickly.
- Ensure Speedy Collection Of Receivables
To channel more money into a business, business persons can offer rewards to their clients for fast payments. Businesses can lower credit periods for their clients. Here, businesses can face certain difficulties and end up jeopardising their own relationships with clients. Wondering how? A company that wants to extend payment terms may deal with clients looking for similar chances. In such cases, businesses can focus on those clients who have the capability to return faster. Businesses can assess this ability by checking publicly available financial data/annual reports.
Note: Business persons can opt for a centralised accounts receivable process as a standard protocol to reduce debt, increase liquidity and outperform competitors. One can also rely on automatic processes to eliminate the chances of human error.
- Negotiate For Extended Payment Terms
If a company does not get any benefit for making early payments to suppliers, chances are it may hold the money. Therefore, if suppliers offer products on fixed credit terms, businesses/companies must negotiate with them to increase the period. Adopting this strategy will help businesses hold money, i.e. cash outflow, for some time until they receive revenues to make payments. Thus, a business can manage the working capital cycle and avoid a cash-flow deficit.
Apart from these, businesses can opt for invoice discounting to efficiently manage the working capital cycle. Wondering how? Read long!
Invoice Discounting As An Efficient Way To Manage Working Capital Cycle
Invoice discounting allows businesspersons to sell unpaid invoices to invoice discounting companies or lending institutions against which they receive a cash advance- a percentage of the invoice’s total value.
Invoice discounting can help successfully manage the working capital cycle in the following ways,
- This funding option provides instant access to cash, which helps speed up the working capital cycle.
- It helps improve cash flow as the advance, i.e., the receivable amount can be converted into cash, leading to a shorter working capital cycle.
Reputed financial solution providers like KredX offer Invoice Discounting on their online platform. Here, businesses can get instant cash by selling unpaid invoices or using them as collateral. The simple eligibility and easy application process make the whole experience hassle-free and quick, thereby enabling a business to shorten its working capital cycle.
To ensure smooth business operations and sufficient cash in a business account, every organisation/firm must focus on maintaining a shorter working capital cycle. This can be achieved by increasing sales, extending the repayment period, etc. However, the search for ways to shorten the working capital cycle must include finding funding options to run business operations. Here, invoice discounting can act as a boon, helping businesses resolve instant cash crunch issues and improve cash flow, thereby, managing the working capital cycle systematically.